Global Risk Regulator - June 2020
- June 2020 Speakers' Corner: The return of geopolitics will cause global banks considerable headaches by Derek Leatherdale at GRI Strategies Ltd.
- Bank of England tells UK banks to prepare for a ‘hard Brexit'
- UK-US trade talks progress well with more scheduled for June
- US negative interest rates would hurt banks, warns Goldman Sachs
- China hits back at US bill that could delist Chinese companies
EU legal order under threat from German court ruling: Germany’s supreme court dealt a body blow to the EU by asserting the supremacy of the member states and by challenging the mandate of the European Central Bank and Court of Justice – potentially unpicking the bloc’s legal order.
'The weakness of the eurozone is that it is a monetary union without a fiscal union to underpin it. Economists argue that until this is in place, the euro will always remain vulnerable. The existential threats against the EU have been steadily piling up, whether it be the rise of euroscepticism, geopolitical activism by China and Russia, member state arguments over EU resources, the COVID-19 pandemic and now the German court ruling.'
FSB throws CCP equity on the line in resolution consultation: The FSB has once again waded into the controversial debate over who pays when a clearing house goes under and in a consultation paper is looking at a range of options including the use of equity.
'The notion of a CCP granting equity to its members in the event of resolution is the most controversial proposal on the table, but nonetheless it is firmly on the table now. In the FSB’s 2017 guidance, it states that resolution authorities should have the power to compensate clearing members that contribute financial resources to a resolution in excess of their obligations under the CCP’s rules and arrangements, in both default and non-default loss scenarios. In its latest paper, the FSB advises resolution authorities to consider at least whether they could compensate clearing members by providing shares in the CCP in return for any cash call or variation margin gains haircutting (VMGH) that is applied beyond the arrangements set out in the CCP’s rulebook.'
COVID-19: European bank trading books pose financial stability risks: Though a decade of global financial reforms has made banks safer, the unusual nature of the COVID-19 pandemic nonetheless exposes European banks to greater than appreciated risks due to the opaque nature of their Level 2 and 3 assets.
'At the opposite, riskier end of the spectrum are banks with large derivative operations: Deutsche Bank and Barclays, both with 9% capital coverage of their Levels 2 and 3 assets, followed by Nordea and Credit Suisse (both with 13%), Société Générale (14%), BNP Paribas (17%), RBS (18%), UBS (19%) and Standard Chartered (20%). A quarter of all European bank assets, or €7,279bn, were measured at ‘fair value’ at the end of 2018. Of this fair value total, banks domiciled in the UK, France and Germany accounted for two-thirds. As of March 31, Barclays alone held £342bn ($430bn) of derivative assets.'
COVID-19 disrupts shift to risk free rates and regulators' deadline: The US Federal Reserve dropping SOFR in favour of Libor for a major funding programme has sparked mixed views as to whether this signals problems for the replacement risk free rates or if it is a minor hiccup.
'The situation in the US is more pressing because SOFR is much newer than Sonia and the dollar market is vastly bigger than sterling. SOFR has had teething issues, partly related to problems in US repo markets; however, there appears to be little appetite to review SOFR. The Alternative Reference Rates Committee has had to bow to the inevitable and allow other alternative rates to develop, provided they meet principles set out by the International Organisation of Securities Commissions (IOSCO) for benchmarks. The big regional banks, for instance, are pursuing with the blessing of US regulators the American interbank offered rate, as it reflects credit risk as opposed to SOFR, which is a risk free rate. There is also work being done to develop a term rate based off SOFR, with around six different initiatives in train, according to industry sources.'
Diverging approaches to IFRS 9 loan provisioning raise APAC fragmentation fears: Although there are common themes among approaches, Asia-Pacific regulators have been pursuing their own measures for how banks should provision for bad loans under IFRS 9, raising fears of further fragmentation.
'Experts say a particular complexity of IFRS 9 is that it requires banks to adopt a staged approach to each loan: institutions must reclassify performing (stage 1) loans as non-performing (stage 2) loans when credit risk increases. This has significant implications for loan-loss provisioning, as stage 2 loans require banks to book lifetime expected-loss provisions, whereas there are only 12-month expected-loss provisions for stage 1 loans. Furthermore, during any payment moratorium, interest continues to accrue on loans. Managers may thus be inclined to hold off acting on underperforming loans that they expect to be fully performing soon. Of course, the longer it takes for a loan to emerge from moratorium to fully performing status, the more difficult it will be to rationalise not reclassifying the loan as a non-performing asset.'
Please contact Ella Jacob at ella.jacob@ft.com for further information.